On May 29th, the IRS issued proposed regulations relating to property transferred in connection with the performance of services under Section 83 of the Internal Revenue Code. http://www.ofr.gov/OFRUpload/OFRData/2012-12855_PI.pdf . Most employers are familiar with these rules in the context of the taxation of restricted stock grants and option grants. Under Section 83, property transferred as com pensation is generally taxed only when the substantial risk of forfeiture lapses (i.e., when the transferred property “vests”).

According to the IRS, these proposed regulations are intended to “clarify” the application of the Section 83 rules. We agree with the IRS that these proposed regulations are mere clarifications and do not significantly change current understanding of the application of Section 83.

These proposed regulations are proposed to apply to property transferred on or after January 1, 2013, but may be relied upon now.

The Clarifications

First, the IRS indicates that the proposed regulations are intended to clarify that a substantial risk of forfeiture may be established ONLY through a service condition (e.g., where an employee receives property from an employer subject to a requirement to continue working through a fixed date in order to retain a property award) or a condition related to the purpose of the transfer (e.g., where an employee receives property from an employer subject to a requirement that it be returned if the total earnings of the employer do not increase). Apparently, the IRS is concerned that taxpayers believe other conditions may establish a substantial risk of forfeiture and that it needs to clarify that only these types of conditions will constitute a substantial risk of forfeiture.

Second, the IRS clarifies that in determining whether a substantial risk of forfeiture exists, taxpayers need to evaluate the likelihood that any condition related to the purpose of a transfer will actually occur.  For example, where stock transferred to an employee is nontransferable and subject to a condition that the stock be forfeited if employer gross receipts fall by 90% over the next 3 years, if this result is extremely unlikely to happen the stock will not be deemed to be subject to a substantial risk of forfeiture. While this example is easy to apply, it is not clear if a more borderline restriction, such as a condition that stock be forfeited if employer gross receipts fall by 15% or 20%, will constitute a substantial risk of forfeiture under this clarification.

Third, the IRS clarifies that transfer restrictions alone do not create a substantial risk of forfeiture. This clarification is consistent with our general understanding of the application of Section 83.

Finally, consistent with Revenue Ruling 2005-48, the IRS clarifies that the only provision of the securities laws that would defer taxation under Section 83 is Section 16(b) of the Securities Exchange Act of 1934. Thus, other transfer restrictions, such as restrictions imposed by lock-up agreements or restrictions relating to insider trading under Rule 19b-5 of the Securities Exchange Act of 1934 will not defer taxation of the property subject to those restriction.

Take Away

Although the proposed regulations do not make any drastic changes to the application of Section 83, they do provide some clarifications to the IRS’s position regarding Section 83. Employers may want to review their equity plans and other plans subject to Section 83 to ensure that the plans are compliant with Section 83, as clarified.

Print:
EmailTweetLikeLinkedIn
Photo of Monique Warren Monique Warren

Monique Warren is a Principal in the White Plains, New York office of Jackson Lewis P.C. Ms. Warren is a member of the Employee Benefits Counseling, Executive Compensation, Benefits Litigation and Workplace Privacy Practice Group.

Ms. Warren counsels employers on employee benefits compliance…

Monique Warren is a Principal in the White Plains, New York office of Jackson Lewis P.C. Ms. Warren is a member of the Employee Benefits Counseling, Executive Compensation, Benefits Litigation and Workplace Privacy Practice Group.

Ms. Warren counsels employers on employee benefits compliance and administrative matters, drafts plan documents and employee communication materials, and represents employers to government agencies and in employee benefit litigation. Her expertise includes health and welfare plans as well as retirement plans.

Ms. Warren has spoken at numerous client and professional association events including SHRM and WEB meetings. She also has presented numerous seminars on employee benefits compliance topics including benefits basics for human resource professionals, HIPAA privacy and security, 409A requirements, and annual legal updates.

Prior to joining the firm in 2006, Ms. Warren was a member of the employee benefits group of a large Chicago law firm and later maintained her own practice in Illinois, representing employers in employee benefits, employment and employment-related immigration matters. While attending law school, she was an intern in the tax clinic at Loyola University Chicago School of Law and was a judicial extern for the Honorable Blanche Manning, Federal District Court, Northern District of Illinois. As a law student, she received academic honors and was a member of the moot court employment law team.

During the ten years prior to attending law school, Ms. Warren directed human resource functions in manufacturing and research enterprises. She was certified as a Senior Human Resource Professional by SHRM in 1996.

Photo of Melissa Ostrower Melissa Ostrower

Melissa Ostrower is Principal in the New York City office of Jackson Lewis P.C.

Ms. Ostrower advises companies on all aspects of employee benefits law, including compliance with ERISA and the Code as well as administrative matters and fiduciary issues relating to benefit…

Melissa Ostrower is Principal in the New York City office of Jackson Lewis P.C.

Ms. Ostrower advises companies on all aspects of employee benefits law, including compliance with ERISA and the Code as well as administrative matters and fiduciary issues relating to benefit plans.  Ms. Ostrower has extensive experience in executive compensation matters and counsels both public and private companies on executive compensation issues, including Section 409A and 162(m) of the Code.

Ms. Ostrower is also a member of the Jackson Lewis healthcare reform task force and is intimately involved in helping Jackson Lewis clients ensure compliance with recently enacted healthcare reform legislation.

Ms. Ostrower is a graduate of Brandeis University (B.A., M.A.), George Washington University Law School (J.D.) where she was a member of The Law Review, and New York University (LL.M.).